ABC Bullion - Addicted to Lowe’s Love of Low Rates

Discussion in 'General Precious Metals Discussion' started by Oddjob, Nov 29, 2019.

  1. Oddjob

    Oddjob Well-Known Member Silver Stacker

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    Latest report from ABC Bullion co-authored by SilverStackers own Bron Suchecki (and John Feeney)

    https://www.abcbullion.com.au/investor-centre/pdf/addicted-to-lowes-love-of-low-rates#.XeDG_GeP7mU

    ABC's weekly Friday PM / markets economy has some real interesting topics this week. Worth the read especially re the RBA's Gov Lowe. A couple of sections copies below. Click above link for full report.

    Congrats to ABC Bullion (Refinery) on PM production levels in Aust market.

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    Addicted to Low(e)
    A couple of weeks ago, we noted that RBA governor Philip Lowe would be softening up the markets for quantitative easing (QE) in a speech on the 26th.

    The point of QE is to push down longer-term interest rates and the so-called “risk-free rate” that is represented by government debt - sure, no risk it won’t get paid back but let’s just ignore the inflated value of that money you’re getting paid back with.

    As most corporate debt is based on the risk-free rate plus a credit risk margin, QE can therefore impact interest rates across the whole economy. The RBA’s current interest rate setting only impacts the shorter end of rates.

    The other attraction of QE for the RBA is that as rates approach zero, QE provides a way for them to avoid (for the moment) unpopular negative rates as they hope lowering longer-term rates will be enough to get them to their inflation and employment targets.

    By lowering the return on Australian investments, QE should also push down our exchange rate as overseas investors pull out money looking for better opportunities.

    Our focus on interest rates is therefore not just because they directly affect the return you earn on your investments but because a weaker exchange rate pushes up AUD metal prices. Every one cent change in the AUD is good for around 1.4% to 1.5% change in AUD gold prices.

    Low interest rates also increase gold demand as returns on its competitors decrease. While Australia is a big producer of gold, we aren’t a big consumer, so any increase in local demand due to low rates is unlikely to have any material impact on the gold price, which is globally determined.

    But not to worry, the central banks of US, Europe, Japan, England and Sweden are pulling their weight, moving from owning securities equivalent to around 5% of GDP to 30% today.

    Philip Lowe said that Australia wouldn’t be joining this group immediately but he didn’t rule it out either, saying only that he didn’t expect we would reach the threshold to do QE in “the near future”.

    He said that threshold is if the cash rate was at 0.25% and their targets of 2-3% inflation and 4.5% unemployment rate were not being achieved.

    Westpac thinks “near future” for QE means the second half of 2020, as it expects two rate cuts next year to 0.25% by June 2020.

    AMP Capital says that “further RBA monetary easing both in the form of rate cuts and quantitative easing point to more downside for the $A” and they see our dollar falling to 0.65 in the months ahead, which at current prices, would result in an Australia gold price of $2,245.

    Lowe must have confidence that QE will work where low interest rates haven’t, as he said that “negative interest rates in Australia are extraordinarily unlikely” because our growth prospects are stronger, our banking system is in much better shape (cough) and have better demographics.

    We found it interesting that while Lowe can see QE being required in Australia, he noted the following negatives from “extraordinary measures” like low/negative rates and QE:

    • reduces the incentive for banks to hold adequate buffers, making episodes of stress more likely in the future
    • creates an inaction bias by regulators or government
    • damages bank profitability, leading to less capacity to lend
    • damages a country’s credibility as it is money-financed government spending
    • creates political tensions as asset purchases disproportionally benefit banks and wealthy people
    • encourages households to save more and spend less due to concerns about lower income in retirement
    Seems like a compelling list to us, but Lowe just says that when considering QE the RBA would balance these side-effects against the positive effects. So like they balance the lost income to savers against mortgage savings to borrowers from low interest rates – as in they won’t.

    The reason for this, market commentators Epsilon Theory say, is that QE creates an addiction to more QE as investors earn less yield on their investments they need continually falling rates to increase the capital value of those investments.

    If rates are zero or negative, then an investor like a super fund can’t generate a return and then it won’t be able to pay a pension. Ditto insurers and other businesses that rely on investment returns. So rates have to keep dropping to create that capital appreciation so everyone can show a “return”.

    Lowe notes in his speech that central bank “extraordinary measures have continued way past the crisis period” and that is unclear when, or if, they will even be unwound. He doesn’t explain why this is the case and we wonder if he ignorant of the reason or just doesn’t want to acknowledge it.

    For an indication of how “extraordinary” those “measures” are, consider this chart of 670 years’ worth of interest rates from Visual Capitalist.

    [​IMG]

    Another Lowe blind spot comes in what assets the RBA would purchase as part of a QE program. He says that they would only look to purchase government bonds and only in the secondary market and would not be buying private sector assets.

    The reason? Because it would represent “a significant intervention by a public sector entity into private markets … and would insert the Reserve Bank very directly into decisions about resource allocation in the economy”.

    Yet he says in his speech that the point of QE is to affect interest rates across all parts of the economy by changing the risk-free rate benchmark. Yes, the RBA would not be choosing one private company’s debt over another, but the buying of government debt is just intervention of a different degree.

    The fact is that the act of having to balance the positive and negative effects of QE, or whether it is better that savers lose income and borrowers gain from lowering rates, is a political one. As Epsilon Theory observe:

    “Democracies are based on the idea that a country’s citizens should determine a government’s decisions to tax, spend and redistribute wealth. Monetary policy [by a central bank] has no such constraints, yet it has similar consequences for the redistribution of wealth from savers to consumers.”

    It suits politicians, of course, for the RBA to hide the fact that it is making political choices behind technocratic speeches. Politicians avoid having to make those choices themselves, and the discipline of the ballot box, by saying that it is out of their hands due to the need for the RBA to be “independent”.

    The concept of central bank independence makes sense when the heavy lifting on managing the economy and wealth distribution is done by politicians. Central bank activities can then be said to be trimming the sails of the economy. Independence is also about preventing government from directly engaging in money printing by making the central bank buy its debt.

    However, when central banks are buying government debt and engaging in extraordinary measures that push rates to 670-year extremes have they not moved their hand directly on to the rudder? Should they not be held accountable for that by the electorate?

    Maybe the answer to why they aren’t is given by Epsilon Theory who say that a central bank is

    “a government agency makes the money and sets the price of money and then sells it to a government-selected banking oligopoly that resells it for a profit. Money is a completely rent-controlled market. … And just like all rent-controlled markets, it’s the rich and the well-connected who make out like bandits.”

    and

    A Bet on $4,000 Gold?
    We have seen a lot of coverage on Twitter of a Bloomberg report that someone bought 500,000 ounces of gold call options (at a cost of $3.50 an ounce) with a strike price of $4,000 an ounce in June 2021.

    Many have been taking this as someone thinking the price will get to $4,000 by June 2021. While that would be a nice outcome, the buyer(s) don’t need the price to get there to make money.

    If the gold price rises significantly, the price of the option will also rise above the $3.50 the buyer paid, at which point they can sell the option back.

    It is a complex trade, as the price of options are based on time to expiry, volatility and other factors.

    So while it isn’t necessarily a bet on $4,000 gold, it is a bullish bet the price of gold will rise significantly well before 2021, and one that someone was willing to stump up $1.75 million for.
     
  2. bron.suchecki

    bron.suchecki Well-Known Member

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    Thanks. I have shorter follow up rant today on central bankers become more political. I suppose I should lay off on the central banker bashing for a bit.
     
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  3. mmm....shiney!

    mmm....shiney! Well-Known Member Silver Stacker

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    Thanks, I’m currently reading it, posting as thoughts come to mind.

    Advocates of QE (traditional Keynesians) are critical of Central Banks and legislators pointing out that accommodative monetary policies are often wound up too soon before the crisis period has ended meaning that the supposed benefits of such policies are not fulfilled. See http://www.paecon.net/PAEReview/issue58/Koo58.pdf. Keynes didn’t advocate QE to eternity, only when private business wasn’t driving the economy. Has there been a point in the last 10 years when private investment was driving a healthy economy? If the answer is no, then the “crisis period” had never finished and the flip-flopping by central banks such as the Fed between loosening and tightening monetary policy may have actually made the situation worse - from a Keyensian viewpoint. From an Austrian viewpoint I’d also agree.

    Maybe it’s the data that Lowe relies on that suggest to him these “crisis periods” are over?
     
  4. mmm....shiney!

    mmm....shiney! Well-Known Member Silver Stacker

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    I like your point about central bank independence as well. It's my position that they shouldn't be independent.
     
  5. leo25

    leo25 Well-Known Member Silver Stacker

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    Lowe is not ignorant, rather he is a good servant to his masters at the BIS. He will do what he is told to do, nothing more, nothing less.
     
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